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| Langley Industries plans to acquire new assets costing $80 million during the coming year and is in the process of determining how to finance the acquisitions. The business plan for the coming year indicates that retained earnings of $15 million will be available for new investments. As far as external financing is concerned, discussions with investment bankers indicate that market conditions for Langley securities should be as follows. Bonds with a coupon rate of 10% can be sold at par. Preferred stock with an annual dividend of 12% can be sold at par. Common stock can be sold to yield Langley $58 per share. The company’s current capital structure, which is considered optimal, is as follows. Long-term debt $175 million Preferred stock 50 million Common equity 275 million Financial studies performed for Langley indicate that the cost of common equity is 16%. The company has a 40% marginal tax rate. (Ignore floatation costs for all calculations.) Questions A. Determine how Langley should finance its $80 million capital expenditure program, considering all sources of funds. Be sure to identify how many new shares of common stock will have to be sold. Show your calculations. B. Calculate Langley’s weighted incremental cost of capital that it could use to assess the viability of investment options. C. Identify how each of the following events, considered individually, would affect Langley’s cost of capital (increase, decrease, no change). No calculations are required. 1. The corporate tax rate is increased. 2. Banks indicate that lending rates will be increasing. 3. Langley’s Beta value is reduced due to investor perception of risk. 4. The firm decides to significantly increase the percent of debt in its capital structure since debt is the lowest cost source of funds. |